The Difference a Printing Press Makes

Contrast how the best-run U.S. states are responding to the recession -- cutting
services, laying off workers, raising taxes, and generally making hard choices
-- with how the Federal government simply writes checks to any and all (while
being praised for its "flexibility" and "creativity") and you begin to understand
the power of a printing press.

States, like all governments prior to the invention of fiat currency, have
to deal with a fixed quantity of wealth that can be divided up but not increased
in the short run. They're like families, in other words, trying to live on
a more-or-less stable income and reluctantly giving up low-priority activities
in hard times. But a national government with a fiat currency doesn't face
these limitations. It just creates as much new paper as necessary to continue
all its normal activities.

So it's no surprise that the worst-run states are becoming increasingly dependent
on federal help, just as a family facing hard times turns to a rich uncle for
a loan. But rich uncles can attach all kinds of strings that end up making
things even worse. Saturday's Wall Street Journal carries an opinion piece
showing just how much worse:

Remember how $200 billion in federal stimulus cash was supposed to save
the states from fiscal calamity? Well, hold on to your paychecks, because
a big story of 2010 will be how all that free money has set the states up
for an even bigger mess this year and into the future.

The combined deficits of the states for 2010 and 2011 could hit $260 billion,
according to a survey by the liberal Center on Budget and Policy Priorities.
Ten states have a deficit, relative to the size of their expenditures, as
bleak as that of near-bankrupt California. The Golden State starts the year
another $6 billion in arrears despite a large income and sales tax hike last
year. New York is literally down to its last dollar. Revenues are down, to
be sure, but in several ways the stimulus has also made things worse.

First, in most state capitals the stimulus enticed state lawmakers to spend
on new programs rather than adjusting to lean times. They added health and
welfare benefits and child care programs. Now they have to pay for those
additions with their own state's money.

For example, the stimulus offered $80 billion for Medicaid to cover health-care
costs for unemployed workers and single workers without kids. But in 2011
most of that extra federal Medicaid money vanishes. Then states will have
one million more people on Medicaid with no money to pay for it.

A few governors, such as Mitch Daniels of Indiana and Rick Perry of Texas,
had the foresight to turn down their share of the $7 billion for unemployment
insurance, realizing that once the federal funds run out, benefits would
be unpayable. "One of the smartest decisions we made," says Mr. Daniels.
Many governors now probably wish they had done the same.

Second, stimulus dollars came with strings attached that are now causing
enormous budget headaches. Many environmental grants have matching requirements,
so to get a federal dollar, states and cities had to spend a dollar even
when they were facing huge deficits. The new construction projects built
with federal funds also have federal Davis-Bacon wage requirements that raise
state building costs to pay inflated union salaries.

Worst of all, at the behest of the public employee unions, Congress imposed "maintenance
of effort" spending requirements on states. These federal laws prohibit state
legislatures from cutting spending on 15 programs, from road building to
welfare, if the state took even a dollar of stimulus cash for these purposes.

One provision prohibits states from cutting Medicaid benefits or eligibility
below levels in effect on July 1, 2008. That date, not coincidentally, was
the peak of the last economic cycle when states were awash in revenue. State
spending soared at a nearly 8% annual rate from 2004-2008, far faster than
inflation and population growth, and liberals want to keep funding at that
level.

A study by the Evergreen Freedom Foundation in Seattle found that "because
Washington state lawmakers accepted $820 million in education stimulus dollars,
only 9 percent of the state's $6.8 billion K-12 budget is eligible for reductions
in fiscal year 2010 or 2011." More than 85% of Washington state's Medicaid
budget is exempt from cuts and nearly 75% of college funding is off the table.
It's bad enough that Congress can't balance its own budget, but now it is
making it nearly impossible for states to balance theirs.

These spending requirements come when state revenues are on a downward spiral.
State revenues declined by more than 10% in 2009, and tax collections are
expected to be flat at best in 2010. In Indiana, nominal revenues in 2011
may be lower than in 2006. Arizona's revenues are expected to be lower this
year than they were in 2004. Some states don't expect to regain their 2007
revenue peak until 2012.

So when states should be reducing outlays to match a new normal of lower
revenue collections, federal stimulus rules mean many states will have little
choice but to raise taxes to meet their constitutional balanced budget requirements.
Thank you, Nancy Pelosi.

This is the opposite of what the White House and Congress claimed when they
said the stimulus funds would prevent economically harmful state tax increases.
In 2009, 10 states raised income or sales taxes, and another 15 introduced
new fees on everything from beer to cellphone ringers to hunting and fishing.
The states pocketed the federal money and raised taxes anyway.

Now, in an election year, Congress wants to pass another $100 billion aid
package for ailing states to sustain the mess the first stimulus helped to
create. Governors would be smarter to unite and tell Congress to keep the
money and mandates, and let the states adjust to the new reality of lower
revenues. Meanwhile, Mr. Perry and other governors who warned that the stimulus
would have precisely this effect can consider themselves vindicated.

John Rubino is author of Clean Money: Picking Winners
in the Green Tech Boom (Wiley, December 2008), co-author, with GoldMoney's
James Turk, of The Collapse of the Dollar and How to Profit From It (Doubleday,
January 2008), and author of How to Profit from the Coming Real Estate
Bust (Rodale, 2003). After earning a Finance MBA from New York University,
he spent the 1980s on Wall Street, as a currency trader, equity analyst and
junk bond analyst. During the 1990s he was a featured columnist with TheStreet.com and
a frequent contributor to Individual Investor, Online Investor,
and Consumers Digest, among many other publications. He now writes
for CFA Magazine and edits DollarCollapse.com and GreenStockInvesting.com.